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Analysis

Next out of the block

There has been so much coverage of the Bitcoin phenomenon that you might think that most people (at least in the financial technology world) have a grasp of how it works and what the key issues are.

Once you start talking to those who have been following it a bit longer, however, the conversation can start to take on a geeky one-upmanship aspect pretty quickly: one party will say Bitcoin is “just the poster child” for a whole set of crypto currencies, the other will cite the Dutch tulip and dismiss them all as speculative bubbles, which the next will deny by pointing out that the US Treasury has deemed Bitcoin equivalent to property for tax purposes.

The conversation will spiral on through the suitability of crypto currencies for legitimate business, one side claiming that their ‘anonymous’ nature means that they are suitable only for money laundering and other dubious activities, the other pointing out that the underlying mechanism is far from anonymous. At the Money20/20 conference in the US last year, one representative of a US law enforcement agency expressed a preference for money launderers to use Bitcoin because they would be easier to catch given the audit trail built into the blockchain that is at the heart of all crypto currencies.

Ultimately, all crypto currency conversations become discussions of the potential of blockchain technology as “a mechanism of the exchange of value”. It is a phrase you will hear if you go anywhere near the many discussions that are taking place on the topic during Sibos and it is behind what some think is a much more important aspect of the technology.

As London-based consultancy Z/Yen put it earlier this year: “For many people the big story is not Bitcoin, rather it’s the blockchain technology that makes tens of crypto currencies work. Working since 2009, forged in a global furnace of libertarian money, trade, avarice, criminality, espionage and law enforcement, Bitcoin and other crypto currency experiments provide increasing confidence that blockchains are robust in harsh environments and have a bright future.”

Z/Yen’s description of what a blockchain actually is comes across rather more prosaically: “A blockchain is a transaction database shared by all nodes participating in a Bitcoin protocol system – a public ledger that prevents making the same transaction twice and is nearly indestructible. Every new block of transactions contains a hash of the previous block, creating a chain of blocks from the ‘genesis’ block to the current block. A full copy of a blockchain contains every transaction ever executed.”

That last bit is central to why law enforcement agencies see blockchains as less opaque when it comes to tracing the history of a transaction and why some people think that there are opportunities to use the technology in situations where the transactional information could be combined with other ownership information, such as title deeds in property transactions.

This confusion about the anonymity or otherwise of blockchain technology is one of five ‘myths’ about crypto currencies identified by Zilvinas Bareisis of research firm Celent, in a recent report The Disruptive Potential Of Bitcoin: why everyone in financial services should care.

“It seems that everyone assumes that because it is a crypto currency, it is encrypted, when the opposite is actually true,” says Bareisis. “It uses cryptography to generate the blockchain, but it is transparent. It is true that they are pseudonymous; there is no direct and obvious link between the wallet address and the private key owner. On the other hand, all transactions are recorded on a public ledger for posterity and available for anybody’s inspection.”

Bitcoin itself, however, may be the AltaVista to Google’s search engine dominance, says Bareisis. AltaVista was a search engine started in the mid-1990s by Digital Equipment Corporation (DEC); it was bought by Yahoo, while DEC has been absorbed into what is now HP.

The point Bareisis is making is that in many technology developments, the early pioneers are not always the ones that succeed in the long run. Bitcoin itself may turn out to be just one step in the road to blockchain technology being the dominant approach.

At which point in the conversation, someone will mention Ripple. (And you will up the ante by mentioning Ethereum.)

Ripple is certainly the most interesting of the post-Bitcoin blockchain technologies from the point of view of the payments world. It is not something that is exchanged, like generic crypto currencies. But it is a method of making the exchange, with the nature of what is being exchanged rather irrelevant.

In the words of the Ripple Labs website: “Ripple is an open-source, distributed payment protocol. It enables free and instant payments with no charge backs and in any currency – including dollars, yen, euros, Bitcoins and even loyalty points. Businesses of any size can easily build payment solutions, such as banking or remittance apps and accelerate the movement of money on Ripple. Ripple enables the world to move value like information moves today.”

The claim is that the Ripple Transaction Protocol (RTXP) creates a payment network that automatically processes payments, currency exchange and other financial transactions. “RTXP can be used, modified, and implemented by anyone for free,” say its developers.

It’s not an idle boast: in the 30 days prior to writing this article, Ripple had been used to move some $30 million around the world. Not a sum of money that will make Sibos delegates pause for breath, but it has been doing this for a while and is attracting attention from serious banking institutions.

“Being able to link to another institution and pass value without having to go through any intermediaries is definitely something that makes a lot of sense,” says Ather Williams, head of global payments at Bank of America Merrill Lynch (BAML). “Start-ups are always eager to change the world, but there is a lot of investment in things like Swift that are very secure, very robust – and work, so at this moment, deciding why you would replace them is a bit of a head scratcher.”

One reason might be that it is easy to set up and much cheaper than most existing routes.

“Ripple is interesting as a technology for many reasons. When I first looked at it, I saw the easy integration from the banks’ side, but the challenges for me come with the network of nostros run by FX traders in the middle,” says one banker “In terms of moving money around I obviously see the benefit of book transfers, which can be 70 per cent cheaper than a wire for banks to process, but managing that network of nostros and the KYC and AML processes that come with it is where we all pause.”

Fiona Hamilton, vice-president Emea at Volante Technologies, says one reason for hesitation is that there is more to the transmission of financial information than the simple transaction information. “Yes, it is a message, but there are a lot of aspects of the way the financial industry works that you need to look at. The cost of the message is not the reason for the costs of the overall transaction and those cheering Bitcoin and the rest have to think about that,” she says. “Virtual currencies such as Bitcoin and open payments systems based on virtual currencies, such as Ripple, are now maturing. Much like the now ubiquitous PayPal, one of these alternatives or another as yet unknown, will become a viable alternative to some facets of a traditional banking relationship.”

Ripple Labs says Ripple is technology for routing payments and settling funds; it does not replace existing networks such as automated clearing houses in the US, Bacs in the UK and international wire services. On the contrary, it “enables them to become faster, cheaper and more interconnected. Banks, clearing houses and governments can build simple, powerful interbank payment networks on top of Ripple, enabling payment execution and fund settlement to occur simultaneously and in real time”.

Ripple has also taken steps in the real world with Munich-based Fidor Bank, which earlier this year became the first bank to integrate the Ripple protocol.

“Ripple is changing the rules of the game for financial institutions, enabling real-time settlement in any currency to strengthen customer relationships and positively impact the bottom line,” says Chris Larsen, chief executive of Ripple Labs. “As an innovator and leader in the banking industry, Fidor is using Ripple to define a new standard for what a bank can be and how it can serve its customers.”

Fidor is using the Ripple network to provide customers with faster and more affordable money transfer services “while deploying the protocol’s real-time settlement functionality to power efficient interbank payments between branches and with other financial institutions”.

Matthias Kröner, chief executive of Fidor, says: “Ripple enables us to securely and instantly send money anywhere in the world at no additional cost and through the same customer facing products and relationships we offer today. With Ripple, we can deliver a superior banking experience at a fraction of the time and cost traditionally expected of a financial institution.”

It is this kind of project and implementation that is getting Ripple serious attention from more than just the technology side of institutions. As ever, there is a reflexive instinct in the financial services world to view new things with a suspicious eye and to look that gift horse firmly in the mouth. What will it replace? It doesn’t help that the language of innovation these days is littered with connotative phrases such as disintermediation and disruption.

“How it plays a part of the ecosystem is interesting to consider: at the moment I’d say it is more of a threat to the ACHs than it is to Swift,” says one banker.

From a more prosaic technical perspective, others argue that like the TCP/IP protocol that underpins the internet, Ripple and the rest are simply new and (perhaps) improved solutions to existing problems and will take some time to become mainstream. When Swift migrated to a TCP/IP-based network it wasn’t described as disruptive, it was seen as an improvement in the technology and a good thing. Why should Swift implementing the Ripple Protocol be seen as different?

“It is going to be a slow movement,” says BAML’s Williams. “That said, there are things that have been around for ages but that haven’t really taken off, like electronic invoicing or the passing of documents in open account trading and as a protocol to address that sort of problem the emerging remittance networks are very interesting. You could get easy adoption and it is a better version of the infrastructure behind some of the Bitcoin-based proposals. It isn’t trying to replace fiat currencies, it is just saying ‘there has to be a cleaner, better, way of transferring value’.”

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